The Monetary Policy Committee of the Central Bank of Iceland raised the policy rate by 0.25 percentage points in May, in line with expectations. This is the second raise in a row and, alongside the policy rate decision, the CBI published a new forecast showing a significantly deteriorating inflation outlook and worse growth prospects. We see wide-spread signs of a cooling economy. Household payment card turnover contracted considerably in April and unemployment levels are currently higher than the same time last year. A cooling of the system lowers the risk of inflation becoming entrenched yet it is nevertheless persistent at the moment and can be expected to remain so while oil prices continue to be high.
Inflation measured 5.1% in May and was higher than we forecast. The discrepancy is primarily caused by rising airfares to and from Iceland. The two components currently with the most influence on inflation development are fuel and airfares. Fuel prices fell temporarily as a result of VAT cuts while airfares have soared. Without the VAT cuts, inflation would have measured 5.5%. Clearly, oil price increases are currently impacting price developments heavily. Other components mainly have a lowering impact on 12-month inflation, including food and beverages, which has fallen two months in a row. We consider this a sign of decreasing inflationary pressure in general despite growing inflation caused by external factors.
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